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Slide 1: Stephens Inc. June 6, 2001 Timothy J. Quillin tquillin@stephens.com 501.377.8078 M. Raza Rafiq rrafiq@stephens.com Wireless Applications & Services SAY WHAT? Initiating Research Coverage of the Speech Recognition Leaders Nuance Communications (NUAN – OUTPERFORM) SpeechWorks International (SPWX – OUTPERFORM) ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
Slide 2: Stephens Inc. NUANCE COMMUNICATIONS (NUAN-NASDAQ) Timothy J. Quillin, 501.377.8078 M. Raza Rafiq Price (as of 06/05/01): ........................................$17.56 52-Week Range: .................................. $182.00 - $8.86 Dividend/Yield: ....................................................... 0% Market Capitalization: ......................... $561.1 million Shares Outstanding: ................................. 32.0 million Estimated Float (Shares):......................... 30.7 million Average Daily Volume (Shares): .................1,603,755 Book Value Per Share: ........................................$8.88 LTM Sales: .............................................. $54.9 million Debt/Capital:.......................................................... .0% ROE (LTM): .......................................................... NM 12-Month Price Target:.....................................$20.00 Cash FYDec. Rev. (Mil.) % Change EPS 2000A $51.8 165% ($0.59) 2001E $42.5 (18%) ($1.29) 2002E $70.0 64.8% ($0.53) 3-Year Estimate CAGR (Rev.) (2000A-2003E): 27.3% Wireless Applications & Services June 6, 2001 Initial Report OUTPERFORM NUANCE COMMUNICATIONS INC COM (NUAN) Jun 2, 2000 - Jun 5, 2001 U.S. Dollar (Split / Spinoff -Adjusted) High: 182.00 Low: 8.86 Last: 17.52 200 180 160 140 120 100 80 60 40 20 Volume in Millions (max/avg) 10 1 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Chart Courtesy of FactSet Research Systems Inc. Nuance Communications, based in Menlo Park, California, develops, markets and supports natural voice interface software that enables anytime, anywhere access via telephone to Internet content and corporate data. In addition to Nuance 7.0, its core speech recognition software, the Company offers verification software, a voice browser and will soon offer text-to-speech software. Its customers include wireless and wireline carriers, enterprises and speech portals. HIGHLIGHTS AND CONSIDERATIONS • • • We are initiating coverage of Nuance Communications with an OUTPERFORM rating and a $20 price target. In general, we foresee rapid growth for Nuance over the next several years, as its speech recognition software is deployed to improve productivity, lower costs, enhance customer service and even generate revenue. We believe that 2001 will prove to be a pivotal year in the speech recognition industry, mostly in terms of developer and customer education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. Based mostly on anecdotal evidence and our own perception, we view Nuance as slightly more forward thinking than its speech recognition software peers. At this stage in the market’s development, there is still a great deal of customer education required, which makes it more challenging to sell primarily through channel partners, as Nuance does. In 1Q01, Nuance experienced a 40% sequential decline in revenue to $11 million, as the technology spending slowdown had a profound impact on its business. • • ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
Slide 3: Stephens Inc. SPEECHWORKS INTERNATIONAL (SPWX-NASDAQ) Timothy J. Quillin, 501.377.8078 M. Raza Rafiq Price (as of 06/05/01): ........................................$14.50 52-Week Range: .................................. $108.50 - $4.81 Dividend/Yield: ....................................................... 0% Market Capitalization: ......................... $455.4 million Shares Outstanding: ................................. 31.4 million Estimated Float (Shares):......................... 27.9 million Average Daily Volume (Shares): ....................831,250 Book Value Per Share: ........................................$5.27 LTM Sales: .............................................. $36.0 million Debt/Capital:....................................................... .0.6% ROE (LTM): .......................................................... NM 12-Month Price Target:.....................................$19.00 Cash FYDec Rev. (Mil.) % Change EPS 2000A $30.0 114.3% ($0.92) 2001E $49.1 63.4% ($0.82) 2002E $74.6 52.0% ($0.28) 3-Year Estimate CAGR (Rev.) (2000A-2003E): 55.5% Wireless Applications & Services June 6, 2001 Initial Report OUTPERFORM SPEECHWORKS INTL INC COM (SPWX) Aug 1, 2000 - Jun 5, 2001 U.S. Dollar (Split / Spinoff -Adjusted) High: 108.50 Low: 4.81 Last: 14.40 120 100 80 60 40 30 20 10 Volume in Thousands (max/avg) 14950 786 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Chart: Courtesy of FactSet Research Systems Inc. SpeechWorks International, headquartered in Boston, Massachusetts, is a leading provider of over-the-telephone automated speech recognition solutions to carriers, enterprises and speech portals. SpeechWorks provides a total speech recognition solution, including technology, tools and professional services. In addition to its flagship speech recognition software, SpeechWorks 6, the Company offers a text-to-speech product and the SpeechSite turnkey call automation solution. HIGHLIGHTS AND CONSIDERATIONS • • We are initiating coverage of SpeechWorks International with an OUTPERFORM rating and a $19 price target. In general, we foresee rapid growth for SpeechWorks over the next several years, as its speech recognition software is deployed to improve productivity, lower costs, enhance customer service and even generate revenue. We believe that 2001 will ultimately be considered a pivotal year in the development of the speech recognition industry, mostly in terms of developer and customer education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. At this stage in the market’s development, there is still a great deal of customer education required, which favors SpeechWorks’ solutions sales approach. In the first quarter, SpeechWorks grew revenue by 8% sequentially to $11 million. The Company’s focus on providing comprehensive customer solutions seems to be translating into exceptional results, at least in the current environment. • • • ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
Slide 4: TABLE OF CONTENTS INVESTMENT CONCLUSION AND SUMMARY ........................................................................................... 6 OUTLOOK ........................................................................................................................................................... 6 Nuance Communications.................................................................................................................................. 7 SpeechWorks International............................................................................................................................... 7 Speech Recognition and VoiceXML................................................................................................................ 7 Technologies .................................................................................................................................................. 10 Sales Strategies............................................................................................................................................... 12 Staying Power................................................................................................................................................. 14 Capitalization ................................................................................................................................................. 14 Customer and Geographic Diversity.......................................................................................................... 14 Management/Employees............................................................................................................................ 16 Product Development ................................................................................................................................ 16 VALUATION ..................................................................................................................................................... 17 Cash Flow....................................................................................................................................................... 18 Catalysts ......................................................................................................................................................... 19 Risks............................................................................................................................................................... 20 CONCLUSION ................................................................................................................................................... 20 NUANCE COMPANY DESCRIPTION ............................................................................................................ 21 Software Products........................................................................................................................................... 23 Nuance 7.0................................................................................................................................................. 23 Nuance Verifier ......................................................................................................................................... 24 Nuance Vocalizer ...................................................................................................................................... 24 Nuance Voyager ........................................................................................................................................ 25 Nuance Voice Web Server ........................................................................................................................ 25 SpeechObjects ........................................................................................................................................... 25 Nuance Developer’s Toolkit...................................................................................................................... 25 Professional Services...................................................................................................................................... 25 Management ................................................................................................................................................... 26 SPEECHWORKS COMPANY DESCRIPTION................................................................................................ 26 SpeechWorks Relationships with AT&T, AOL and Net2Phone.................................................................... 28 Software Products........................................................................................................................................... 29 SpeechWorks 6.5....................................................................................................................................... 30 SpeechSite ................................................................................................................................................. 31 Speechify................................................................................................................................................... 31 ETI-Eloquence........................................................................................................................................... 32 SpeechSecure ............................................................................................................................................ 32 Professional Services...................................................................................................................................... 33 Management ................................................................................................................................................... 33 Stephens Inc. 4
Slide 5: FIGURES Figure 1 SPEECH RECOGNITION INDUSTRY  Flow Diagram of a Voice-Enabled Customer Care Application................................................................................................................................................................. 8 Figure 2 SPEECH RECOGNITION INDUSTRY  Product Comparison............................................................ 11 Figure 3 SPEECH RECOGNITION INDUSTRY  Key End-Users .................................................................... 13 Figure 4 SPEECH RECOGNITION INDUSTRY  Margin Comparison for 2000.............................................. 13 Figure 5 SPEECH RECOGNITION INDUSTRY  Capitalization Comparison.................................................. 15 Figure 6 SPEECH RECOGNITION INDUSTRY  Customer Concentration Comparison ................................. 15 Figure 7 SPEECH RECOGNITION INDUSTRY  Geographic Concentration Comparison .............................. 15 Figure 8 SPEECH RECOGNITION INDUSTRY  Insider Ownership Comparison........................................... 16 Figure 9 WIRELESS APPLICATIONS INDUSTRY  Valuation Comparison................................................... 17 Figure 10 NUANCE COMMUNICATIONS  Discounted Cash Flow Analysis .................................................. 18 Figure 11 SPEECHWORKS INTERNATIONAL  Discounted Cash Flow Analysis ......................................... 19 Figure 12 NUANCE COMMUNICATIONS  Revenue Composition, 1Q01....................................................... 21 Figure 13 NUANCE COMMUNICATIONS  Selected Customers...................................................................... 22 Figure 14 NUANCE COMMUNICATIONS  Nuance 7.0................................................................................... 23 Figure 15 SPEECHWORKS INTERNATIONAL  Revenue Composition, 1Q01............................................. 27 Figure 16 SPEECHWORKS INTERNATIONAL  Selected Customers............................................................. 28 Figure 17 SPEECHWORKS INTERNATIONAL  Examples of Speech-Activated Services............................. 29 Figure 18 SPEECHWORKS INTERNATIONAL  SpeechWorks Platform ....................................................... 30 Figure 19 SPEECHWORKS INTERNATIONAL  SpeechWorks 6.5 Platform ................................................. 32 Figure 20 NUANCE COMMUNICATIONS  Earnings Model, FY2000A-FY2002E......................................... 38 Figure 21 NUANCE COMMUNICATIONS — Financial Data FY2000A-FY2002E............................................ 39 Figure 22 SPEECHWORKS INTERNATIONAL  Earnings Model, FY2000A-FY2002E................................. 40 Figure 23 SPEECHWORKS INTERNATIONAL  Financial Data, FY2000A-FY2002E ................................... 41 Stephens Inc. 5
Slide 6: INVESTMENT CONCLUSION AND SUMMARY We are initiating research coverage of NUAN and SPWX with OUTPERFORM ratings. We are initiating research coverage of Nuance Communications and SpeechWorks International with identical OUTPERFORM ratings. We are genuinely excited about the potential of speech recognition software to transform the way in which we interact with Internet content and corporate data. We believe that the success of both Nuance and SpeechWorks will be driven primarily by the market’s rapid growth over the next several years and doubt that either of the companies will succeed at the expense of the other. Currently, speech recognition technology is used primarily to deflect calls from live customer service representatives. The economic benefit is reduced headcount. In organizations without a touchtone system, the savings is substantial. Whereas live agent service could easily cost an organization several dollars per call, a self-service system powered by speech recognition may cost less than $0.50. In most cases, a well-designed voice recognition system will also result in lower overall costs than a touchtone system by improving the customer experience and reducing the caller’s propensity to seek live agent help. Longer term, speech recognition software could fundamentally change how consumers access Internet content via either independent or wireless carrier-controlled voice portals. Perhaps more interestingly, mobile professionals will eventually have a truly ubiquitous means of accessing corporate data from the road. Speech recognition technology may eventually be part of a multi-modal platform in which voice input is married to graphic output. For example, a field service technician might query a corporate database by speaking into a handheld device the question, “Where is my next appointment?” and receive a vocal response with the customer’s name and problem along with a map viewable on the device. In the short run, we favor SpeechWorks’ greater revenue visibility and focus on customer solutions. At this stage in the market’s development, there is still a great deal of customer education required, which makes it more challenging to sell software primarily through channel partners, as does Nuance. We are also impressed with SpeechWorks alliances with AT&T, AOL and Net2Phone and see these relationships as key differentiators (see page 30 for more details). Longer term, though, we foresee a large group of skilled developers and systems integrators emerging that will be able to implement complex speech recognition solutions. So in the long run, we favor Nuance’s pure software model, which has positive implications in terms of margins and sustainable growth. In the first quarter 2001, Nuance experienced a 40% sequential decline in revenue to $11.0 million, as the technology spending slowdown had a profound impact on its business. SpeechWorks, on the other hand, grew revenue by 8% sequentially to a nearly identical $11.1 million. SpeechWorks’ focus on providing comprehensive customer solutions seems to be translating into exceptional results, at least in the current environment. At present, speech recognition technology is used mostly to deflect calls from live customer service representatives. Speech recognition technology may eventually be part of a multi-modal platform in which voice input is married to graphic output. In the short run, we favor SPWX’s solutions model with its greater revenue visibility. In the long run, we like NUAN’s pure software model. OUTLOOK In no uncertain terms, we believe that speech recognition initiatives are on hold until economic conditions improve. We emphatically believe that most speech recognition initiatives are on hold until economic conditions improve. We do not expect that either Nuance or SpeechWorks will grow revenue significantly until at least 2002. However, our longer-term view is much more sanguine. We believe that 2001 will ultimately be considered a pivotal year in the evolution of the speech recognition industry, mostly in terms of developer and customer 6 Stephens Inc.
Slide 7: education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. Nuance Communications For NUAN, we forecast total revenue of $9.9 million in 2Q01. We forecast total Company revenue of $9.9 million in 2Q01 (ending June 30), a 10% sequential decline, and $42.5 million for the full year 2001, an 18% decline from the previous year. We expect a cash loss of ($1.29) in 2001. Clearly the Company is suffering from the slowdown in technology spending this year. In 2002 we forecast total revenue to grow by 65%, slightly surpassing $70 million, with license revenue more than doubling. We expect a cash loss of ($0.53), as margins should continue to improve. We anticipate that the Company will use over $100 million of its cash in 2001 and 2002 before turning cash flow positive in 2003 as it leverages its cost structure over a rapidly expanding revenue base. SpeechWorks International For SPWX, we forecast total revenue of $11.6 million in 2Q01. We forecast total Company revenue of $11.6 million in 2Q01 (ending June 30), a 5% sequential increase, and $49.1 million for the full year 2001, an impressive 63% increase from 2000. We expect a cash loss of ($0.82) in 2001. SpeechWorks is faring remarkably well in the current environment, in marked contrast to Nuance. In 2002 we forecast total revenue to grow by 52% to slightly under $75 million, with license revenue growing slightly faster at a 58% clip. We expect a cash loss of ($0.28), as margins should continue to improve. We anticipate that the Company will use over $80 million of its cash in 2001 and 2002 before turning cash flow positive in 2003 as it too leverages its cost structure over a rapidly expanding revenue base. We anticipate rapid growth for both SPWX and NUAN over the next several years. In general, we foresee rapid growth for both SpeechWorks and Nuance over the next several years, as speech recognition software is deployed to improve productivity, lower costs, enhance customer service and even generate revenue. When considering an investment in Nuance or SpeechWorks, there are four key issues to examine: • • • • The outlook for the speech recognition industry; Nuance’s and SpeechWorks’ underlying technologies; Their sales strategies; and Their ability to weather an economic downturn. Speech Recognition and VoiceXML Effective and useful speech recognition, the process of converting audible signals into digital symbols, has been one of the holy grails of technology for the past 20 years. Speech recognition has the power to transform the way we interact with machines. Speech is a natural, efficient and flexible interface with computers. Lack of processing speed has been a barrier to usable speech recognition technology. Stephens Inc. The barrier to usable technology has been as much a lack of raw processing speed as a lack of modeling knowledge. However, with the rapid advances in computing power over the past decade, the technology is beginning to turn up in our everyday life. In fact, a portion of this report was authored without the use of a keyboard using IBM’s Via Voice dictation software and an iMac. From a user’s perspective, the product is marginally useful but frustratingly far from perfection. Neither Nuance nor SpeechWorks offers dictation software. 7
Slide 8: Both Nuance and SpeechWorks focus on telephony solutions in which the speech recognition software understands, rather than just transcribes, natural human language. Current systems are able to understand elements of a full sentence by using either 1) a finite “grammar,” or vocabulary, that will include all variations in the way a particular request can be voiced, 2) a multi-word probabilistic model (N-Grams), or 3) a keyword spotting algorithm. New statistical models, such Nuance’s Say Anything or SpeechWorks’ How May I Help You, are helping build better natural language recognition by dynamically learning from user behavior. This natural language understanding, along with other software components, makes it possible to create user-friendly customer service solutions (see Figure 1). The brokerage and airline industries have been early adopters of speech-driven self-help systems for retrieving quotes and flight information, respectively. These proprietary solutions are generally built on Interactive Voice Response (IVR) platforms from vendors such as InterVoice-Brite or Avaya. The return on investment is generally quite high, as the software helps reduce calls to live customer service agents. Figure 1 SPEECH RECOGNITION INDUSTRY  Flow Diagram of a VoiceEnabled Customer-Care Application Source: VoiceXML Forum Stephens Inc. 8
Slide 9: VoiceXML might prove to be a catalyst for the deployment of speech recognition technology. The recent emergence of the VoiceXML standard is likely to accelerate the deployment of speech recognition technology. Compared to proprietary IVR solutions, VoiceXML leverages existing corporate investments in Web infrastructure, simplifies the development effort by creating an open standard, and supports more deployment options (e.g., hosted applications). Both Nuance and SpeechWorks are proponents of VoiceXML, though Nuance seems to be more vocal regarding the importance of the standard to the industry. VoiceXML is a Web-based markup language like HTML (hypertext markup language). Unlike the graphical HTML, VoiceXML uses a voice browser with audio output (computer-synthesized and/or recorded) and audio input (voice and/or keypad tones). The goal is to enable voice access and interactive voice response (e.g., by telephone, PDA, or desktop) to Web-based content and applications. Among the potential speech recognition solutions utilizing VoiceXML are the following: • Customer service. This is the most typical speech recognition solution and is really just a much more robust version of simple touchtone self-service. With VoiceXML, a caller could be routed from one VoiceWeb site to another. For example, a retail store’s voice site might transfer a caller to a specific vendor’s site if the customer wants product information. Content. This might include the ability to retrieve personalized information such as address books, calendars, weather reports, travel information and stock quotes. Portals such as TellMe, BeVocal and HeyAnita offer voice content. Unified messaging (UM). UM allows users to access e-mail, voice mail, instant messaging (IM), short messaging service (SMS) and faxes in one place, either in text or spoken format. Intranets. For instance, users could order supplies or access human resources information. More interestingly, field sales personnel might place orders by phone or access a CRM (customer relationship management) system. E-Commerce. Usage in this area probably makes sense only in specific applications such as stock trading or ticket purchases, though Office Depot already successfully processes orders from business customers via a speech recognition system. VoiceXML is a Webbased markup language that uses a voice browser with audio output and input. • • • • Our due diligence leads us to believe that there is substantial interest in speech recognition. This may not be the breakthrough year for VoiceXML applications, however. The decrease in technology spending is having a profound impact on emerging technologies such as speech recognition. Corporations are now generally reluctant to deploy new technology even in light of clear evidence of substantial ROI. However, the education process has not stopped. Our due diligence leads us to believe that, while most companies are reluctant to acquire the technology this year, there is substantial interest in speech recognition. We believe that this interest will translate into accelerated sales in 2002. Although the potential market for speech recognition software is difficult to quantify, we have no doubt that it is big. Cahners In-Stat Group expects the market for speech recognition software to grow from $200 million today to $2.7 billion by 2005. This strikes us as an ambitious forecast but still indicative of the market’s potential. Just in streamlining customer service operations, we would expect a market opportunity of $1 billion. Stephens Inc. In the streamlining of customer service operations alone, we would expect a significant market opportunity. We can quantify this specific market opportunity in terms of overall call center headcount reduction. We estimate that there are over 4 million call center seats throughout the world. Assuming just $25,000 per seat, the total labor costs are approximately $100 billion. We believe that at least 20% of the seats could be displaced by speech recognition systems for a total cost reduction of $20 billion. If annual software 9
Slide 10: expenditures are just 5% of the cost reduction, this segment of the market is still a $1 billion opportunity. Consumer demand for broader VoiceXML applications is still unproven. While we cannot envision surfing the Voice Web anytime soon, we believe that consumers will ultimately embrace numerous specific services, such as voice dialing and unified messaging. Speech recognition technology should help overcome the input constraints of small handheld devices, especially with the introduction of 2.5G and 3G networks that will allow simultaneous voice and data connections. Perhaps the key to winning consumer acceptance, though, is designing intelligent and friendly user interfaces. Simple things like the rhythm or tone of speech output can have a profound impact on user acceptance. The biggest threats to the market are commoditization of the core technology and increased competition. The biggest threats to the speech recognition software market are commoditization of the core technology and increased competition. Both Nuance and SpeechWorks purchased most of their core technology from third parties, including speech recognition technology from SRI International and MIT, respectively. While their current products are much more advanced than the technology the companies purchased, there is still the threat, albeit a weak one, of a movement towards open source code for the core speech recognition technology as VoiceXML is developed. Nuance’s and SpeechWorks’ competition includes the embattled Lernout&Hauspie, InfoSpace (Locus Dialogue), and Philips Electronics as well as the original VoiceXML sponsors—AT&T, IBM, Lucent and Motorola. We are most concerned about IBM, which has developed high-quality speech recognition software but is not currently marketing products to the enterprise market. However, if Nuance and SpeechWorks prove that there is a viable market, IBM may devote more resources to this area. Technologies On the surface, NUAN and SPWX appear to be very similar organizations. At first glance, and even at second glance, Nuance and SpeechWorks appear to be very similar organizations. Both market speech recognition software to telecommunications carriers, enterprises and portals that enables access to Internet content and corporate data via telephones. Both posted approximately $11 million in revenue in the latest quarter, and both have market capitalizations near $450 million. Certainly their product lines bear a striking similarity (see Figure 2). Overall, we do not believe that either firm can claim technical superiority. Still, there is a bit of an “East Coast/West Coast” feud between the two Companies that deserves closer examination. Nuance can trace its roots back to SRI International, an independent R&D and consulting shop based in Menlo Park. Nuance was founded as a vehicle to commercialize SRI’s voice interface software. Nuance’s speech recognition technology uses the Hidden Markov Model (HMM), a statistical process model used in speech recognition since the early 1970s, combined with Gaussian-mixture processing, which divides digitized speech into short segments for faster processing. By and large, we do not believe that either firm can claim technical superiority. Similarly, the SpeechWorks technology, developed at MIT, relies on segmental systems rather than the frame-based HMM to account for the entire phonetic segment, which again allows for faster processing and increases accuracy. So, the core technologies are not a significant point of differentiation. Stephens Inc. 10
Slide 11: Figure 2 SPEECH RECOGNITION INDUSTRY  Product Comparison Product Speech Recognition Engine Text-To-Speech Authentication Browser VoiceXML Tools Developer Tools Statistical Language Models Turnkey Auto-Attendant NUAN Nuance 7.0 Vocalizer Verifier Voyager VoiceXML Interpreter SpeechObjects Say Anything na SPWX SpeechWorks 6.5 Speechify/Eloquence SpeechSecure Speech Browser OpenVXI DialogModules How May I Help You SpeechSite Source: Company documents and Stephens Inc. Nuance claims that its software handles noisy environments better than SpeechWorks’ as a result of its extensive work with General Motors. SpeechWorks disputes the claim, and we have not found any independent verification. What is indisputable is that Nuance’s speech recognition software supports 25 languages, while SpeechWorks, supports just 18. However, we cannot imagine that support for the additional seven languages is a significant driver of revenue. Likewise, Nuance’s verification software, instant messaging product and its voice browser are points of differentiation but are not significant revenue contributors. System architecture is the biggest difference between the technologies offered by SPWX and NUAN. Perhaps the biggest difference between the two technologies is the system architecture. Nuance uses a distributed client/server architecture, while SpeechWorks favors an “N+1 sparing” approach. We find the Nuance approach more impressive, but our due diligence leads us to believe that buyers of IVR systems are as likely to favor SpeechWorks’ single server “in the skins” approach. Key points regarding each architecture are listed on the next page. Stephens Inc. 11
Slide 12: Nuance’s Distributed Architecture O Balances load across multiple servers. O High fault tolerance. O More efficient use of hardware. O More accuracy by leveraging multiple CPUs. SpeechWorks’ N+1 Sparing O Relies on a single server with a backup. O Seamless integration with IVR platforms. Source: Company Documents We believe that the TTS software offered by both NUAN and SPWX has bright prospects. Although text-to-speech (TTS) is not yet a meaningful contributor to earnings for either Company at this time, the product has a bright future, and it is worth noting the differences between the Nuance and SpeechWorks offerings. While Nuance’s offering has yet to ship, we doubt that its U.S. English version will be technically superior to the Speechify product SPWX licensed from AT&T. On the other hand, SpeechWorks’ other TTS offering, Eloquence, supports multiple languages but is based on a less natural sounding formant technology. Nuance may have an edge selling its new product to multinational customers. We summarize the key points regarding TTS below. Nuance’s Vocalizer O Has not shipped. O Cobbled together from multiple vendors, including Lucent and Fonix. O Will support nine languages with state-of-the-art concatenated technology. SpeechWorks’ Speechify/Eloquence O Speechify technology licensed from AT&T. O Speechify may be best on the market—licensed by Microsoft, AOL and Yahoo! O Eloquence product supports 13 languages but uses outdated formant technology, which produces a less life-like voice. Source: Company Documents Net-net, we are not convinced that either Company’s product line is wildly superior to the other, and our feedback from systems integrators indicates that neither is substantively better. Still, based mostly on anecdotal evidence and our own perception, we view Nuance as slightly more forward thinking than its speech recognition software peers. Sales Strategies NUAN and SPWX offer their products to similar customers. In 2000, NUAN derived 72% of its revenue through resellers versus SPWX's 38%. Not only are Nuance’s and SpeechWorks’ technologies similar, but also the customers that use their products are comparable (see Figure 3). It almost appears that customers in each key market segment are evenly divided between the two competitors. However, there is a very clear difference in the way in which Nuance and SpeechWorks market their products. In 2000, 72% of Nuance’s revenue was achieved through resellers, including 22% of sales through Nortel. In contrast, SpeechWorks derived just 38% of its 2000 revenue from resellers, OEMs and ASPs, including 16% from call automation vendor InterVoice-Brite. SpeechWorks has a more significant professional services organization and even resells hardware as part of its end-to-end solutions. 12 Stephens Inc.
Slide 13: Figure 3 SPEECH RECOGNITION INDUSTRY  Key End-Users Industry Financial Services NUAN Fidelity Investments Charles Schwab TD Waterhouse American Airlines British Airways Sprint PCS Telespree BeVocal Tellme SPWX Ameritrade CSFBdirect E*TRADE United Airlines Continental Airlines BellSouth WorldCom AOLbyPhone HeyAnita Airlines Telecommunications Portals Source: Company reports and Stephens Inc. We believe that the bottom line is that Nuance sells products, while SpeechWorks sells solutions. The bottom line, in our opinion, is that Nuance sells products, while SpeechWorks sells solutions. As we mentioned earlier in the report, at this early stage in the market’s growth, it may be necessary to hold the customers’ hands through the design and implementation phases. Thus, SpeechWorks’ direct sales approach appears to be more successful in the current environment, as witnessed by its 8% sequential sales growth in the 1Q01 compared to Naunce’s 40% sequential decline. In recognition of this, Nuance recently introduced a comprehensive set of design and production services aimed at helping businesses build voice applications. To be clear, though, we do not expect that Nuance will build a large systems integration organization. As this market matures and more qualified integrators emerge, the need for direct customer contact may decrease. Therefore, Nuance’s pure software model may ultimately prove to have positive implications for both sustainable growth and attractive margins. NUAN should generally have higher gross margins than SPWX. In terms of margins, Nuance’s numbers are closer to what we expect from a software firm (see Figure 4). In 2000, the Company’s revenue from software licenses was roughly 72% of total revenue, and its gross margin was close to 80%. On the other hand, SpeechWorks derives just 54% of total revenue from product licenses, and its gross margin in 2000 was closer to 60%. In addition, Nuance’s R&D expense as a percent of revenue was higher than SpeechWorks’, while SpeechWorks’ administration costs were much higher than those of Nuance (though this is somewhat misleading due to expense allocation). Interestingly, sales and marketing expenses for the two competitors were an identical 66% of sales. Figure 4 SPEECH RECOGNITION INDUSTRY  Margin Comparison for 2000 FY2000 Gross Margin S&M % of Rev. R&D % of Rev. G&A % of Rev. NUAN 79% 66% 39% 19% SPWX 63% 66% 29% 58% Note: Comparisons ot G&A expenses are generally a challenge due to different allocation methods. Source: Company reports and Stephens Inc. Stephens Inc. 13
Slide 14: Another difference is in revenue recognition. For Nuance, the revenue clock starts at zero each quarter and, thus, there is little visibility. SpeechWorks, on the other hand, often recognizes revenue over the approximate six months that it takes to implement the software or solution. The upshot is that SpeechWorks’ management enjoys 50% visibility into the next quarter’s results, which is obviously a comfort in this uncertain market. Staying Power The fundamental question is, How well can software vendors hold up in a difficult macroeconomic environment? The issue of the moment is how well any given software vendor can hold up in a difficult macroeconomic environment and an overall tech spending slowdown. We have little doubt that speech recognition systems have a substantial quantifiable ROI, especially in customer service and auto-attendant applications. However, there is still a great deal of skepticism from potential customers, and therefore, we are pessimistic about the nearterm prospects for both Companies’ products. In 2001, we may be more likely to see limited-scope test projects (e.g., an internal voice directory) to evaluate the potential for speech recognition rather than sweeping business process changes to truly take advantage of the technology. Again, we believe that SpeechWorks’ direct customer interaction will help it outpace Nuance in the short run. In any case, we are not assuming that either Company will grow rapidly in 2001. Regardless of the specifics, we are not assuming that either firm will grow rapidly in 2001. We do, however, foresee a bright long-term future for speech recognition and for the two Companies. So we will examine the Companies’ staying power, or their ability to emerge from what may be a challenging 2001 as strong, if not stronger, businesses— capitalization, customer and geographic diversity, management and employee commitment, and product development. Capitalization First, we must consider the two Companies’ cash positions and their capital requirements over the next year or two, as it may be a challenge to raise additional funds in the current environment. Both companies completed an IPO in 2000 and are well capitalized. We estimate that neither one will require additional capital over the next three years (see Figure 5). Customer and Geographic Diversity We tend to place a premium on companies with a broadly diversified customer base in terms of geography and vertical industry groups. Next, we consider the Companies’ customer and geographic diversification. We tend to place a premium on firms with a broadly diversified customer base in terms of geography and vertical industry groups. Both service roughly the same customer base, and neither appears over-exposed to any customer or group of customers. The top five customers for each of them make up roughly half of revenue (see Figure 6). However, Nuance is much farther along in terms of international expansion, with almost half of its revenue derived from overseas compared to less than 10% at SpeechWorks (see Figure 7). Clearly, this has not necessarily helped in 2001, but its broad geographic reach should serve it well in the future. Stephens Inc. 14
Slide 15: Figure 5 SPEECH RECOGNITION INDUSTRY  Capitalization Comparison, 1Q01 ($ in millions) Cash and Short-term Inv. Total Assets Debt Total Liabilities Total Liab. and Equity EBITDA Loss in 1Q Cash in Years Source: Company reports and Stephens Inc. NUAN $206.07 275.49 0.00 33.07 275.49 ($14.42) 3.6 SPWX $98.09 147.88 0.67 10.38 147.88 ($8.29) 3.0 Figure 6 SPEECH RECOGNITION INDUSTRY  Customer Concentration Comparison, 1Q01 NUAN SPWX Other 49% Top 5 51% Top 5 47% Other 53% Source: Company reports and Stephens Inc. Figure 7 SPEECH RECOGNITION INDUSTRY  Geographic Concentration Comparison, 1Q01 NUAN SPWX International 9% International 47% U.S. 53% U.S. 91% Source: Company reports and Stephens Inc. Stephens Inc. 15
Slide 16: Management/Employees Third, we evaluate management’s and employees’ commitment to building a world-class organization. Anecdotally, we can vouch for enthusiasm throughout the Nuance organization after spending three days at its V-World conference and were impressed by Nuance’s shared culture. While we have not had the same broad exposure to SpeechWorks’ employees, our feedback from customers indicates that its people have a strong commitment to service. We generally believe that the SPWX/NUAN competition has a positive impact on employee morale at both organizations. We generally believe that the SpeechWorks/Nuance competition has a positive impact on employee morale and generates pride at both organizations. The common pursuit of the two firms, though, is more usable speech recognition technology and, thus, an improved man/machine interface. This quest tends to attract some of the brightest minds in the world. More substantively, neither one’s management has a particularly impressive level of insider ownership, which might suggest an obvious incentive to build value for the long run (see Figure 8). Clearly, though, the insider stake at SpeechWorks is substantively greater. Figure 8 SPEECH RECOGNITION INDUSTRY  Insider Ownership Comparison NUAN Shares SPWX Shares 1,175,561 or 4% 3,460,016 or 11% 30,780,439 27,947,984 31,956,000 31,408,000 Total Insider Ownership Float Total Shares Outstanding Source: Company reports and Stephens Inc. Product Development Currently NUAN holds one U.S. patent versus SPWX’s five. Finally, we believe it is important to consider the ability of each Company to develop or acquire technology that will keep it at the vanguard of the sector. One clue might come from their patent portfolios. Nuance holds one U.S. patent and has multiple patents pending. SpeechWorks has 5 U.S. patents and has filed for another 12 in the U.S. and several others overseas. While software patents should not be viewed as protection from competition, they at least provide some legal grounds to defend core technologies. Neither Company appears to have any defensible intellectual property, and both have licensed nonexclusive core technology. That said, improvements in speech recognition software are made through trial and error. Both NUAN and SPWX are distancing themselves from potential competitors by learning at the speed of their market share and constantly improving their products. So a new market entrant could license SRI or MIT technology, but it would be five years behind the times. Nuance currently employs approximately 120 engineers, and its cash R&D expenses of $5.24 million equaled 48% of revenue in the first quarter. SpeechWorks has over 100 engineers on its payroll, and cash R&D expenses of $3.35 million were roughly 30% of first quarter revenue. Our point here is that both Companies possess experience and R&D commitment that, should translate into a growing portfolio of valuable intellectual property, which we view favorably. Neither company appears to have any defensible intellectual property, and both have licensed nonexclusive core technology. Stephens Inc. 16
Slide 17: VALUATION Based on a price to revenue analysis, neither the shares of Nuance nor SpeechWorks could be considered inexpensive (see Figure 9). However, their leadership positions in an attractive but nascent market may warrant premium multiples. Figure 9 WIRELESS APPLICATIONS INDUSTRY  Valuation Comparison (dollars in millions except per share amounts) Stephens 6/5/01 Shares Market Company Ticker Rating Price Out Cap 724 Solutions SVNX $8.76 53.6 $469.4 Aether Systems AETH N 11.58 40.5 468.4 At Road ARDI 1.90 42.9 81.5 AvantGo AVGO 2.28 31.3 71.5 Comverse Technology* CMVT 67.52 187.5 12,660.0 Extended Systems XTND B 7.77 10.7 83.4 GoAmerica GOAM 2.40 52.3 125.6 InfoSpace INSP 3.83 323.1 1,237.6 Nuance Comm. NUAN O 17.56 32.0 561.1 Omnisky OMNY 2.30 60.1 138.1 Openwave Systems OPWV N 42.99 177.8 7,642.5 Portal Software PRSF 5.31 168.2 893.1 Pumatech* PUMA O 3.81 44.2 168.5 SignalSoft SGSF 8.75 23.6 206.5 SpeechWorks Int'l SPWX O 14.50 31.4 455.3 TeleComm. Systems TSYS O 4.00 27.4 109.6 Average * Revenue for the 12-month periods ending in January; all others are calendar year. Note: Companies in bold are Stephens Inc. estimates. Source: IBES and Stephens Inc. Revenue CY00A CY01E $21.2 $72.3 58.2 149.3 10.6 29.9 16.3 34.5 1,225.1 1,461.4 39.1 28.4 13.9 91.2 214.6 214.8 51.8 42.5 11.1 38.3 286.6 551.0 268.3 350.2 38.3 43.7 13.6 32.6 30.0 49.1 66.9 81.2 P/Revenue 2000 2001 22.1 6.5 8.1 3.1 7.7 2.7 4.4 2.1 10.3 8.7 2.1 2.9 9.1 1.4 5.8 5.8 10.8 13.2 12.5 3.6 26.7 13.9 3.3 2.6 4.4 3.9 15.1 6.3 15.2 9.3 1.6 1.3 9.9 5.5 Our 12-month price targets are based on a price to revenue multiple applied to our second 12-month revenue estimate for each firm. Our 12-month price targets are based on a price to revenue multiple applied to our second 12-month revenue estimate for each firm. Our 12-month target for Nuance is $20.00, or 14% above the current price, based on a price to revenue multiple of 8 applied to our second 12-month revenue estimate of just over $80 million. Our 12-month price target for SpeechWorks is $19.00, or 31% above the current price, based on a price to revenue multiple of 7 applied to our second 12-month revenue estimate of $83.4 million. We afford Nuance a slightly higher multiple than SpeechWorks based on the slightly higher gross margins that should be possible with its indirect sales model. Stephens Inc. 17
Slide 18: Cash Flow We believe that an assessment of a stock’s value should include a discounted cash flow analysis as a means to verify the plausibility of a valuation if not to pinpoint a price target. Our DCF analyses suggest that both Nuance’s and SpeechWorks’ current valuations are basically fair, given our reasonable assumptions of slowly declining revenue growth beginning in 2005 and peak net margins in 2007 of roughly 20% for Nuance and 17% for SpeechWorks (see Figures 10 and 11). Importantly, we believe that Nuance’s $200 million in cash and SpeechWorks’ $100 million in cash should provide more than adequate capital for growth until both are expected to turn cash flow positive in FY2003. Our DCF analyses suggest that both NUAN’s and SPWX’s current valuations may be slightly low. Figure 10 NUANCE COMMUNICATIONS  Discounted Cash Flow Analysis (dollars in millions except per share) Revenue Year-to-Year Change Net Margin Earnings Depreciation & Amortization Non-Cash Compensation Other Cash from Operations Net Investments Free Cash Flow Year-to-Year Change Free Cash Flow Per Share Terminal Value 2000A 2001E 2002E 2003E 2004E 2005E 2010E $51.8 $42.5 $70.0 $107.0 $160.5 $232.7 $557.2 (18%) 65% 53% 50% 45% 8% NM NM NM 5% 10% 15% 20% ($23.5) ($49.0) ($21.5) $5.1 $16.0 $34.9 $111.4 2.7 6.0 6.0 6.0 6.0 6.0 6.0 4.9 5.3 1.9 1.9 1.9 1.9 1.9 (0.3) (2.4) (2.8) (3.4) (3.4) (3.4) (3.4) ($21.1) ($45.4) ($18.3) $9.6 $20.5 $39.4 $115.9 (9.1) (32.0) (6.0) (6.0) (6.0) (6.0) (6.0) ($30.2) ($77.4) ($24.3) $3.6 $14.5 $33.4 $109.9 306% 130% 8% (0.95) (2.42) (0.76) 0.11 0.46 1.05 3.44 $41.64 Shares Outstanding 32.0 2001-2010 Cash Flows Per Share $3 Terminal Value Per Share $10 Total Discounted Value Per Share $13 Excess Cash Per Share $1 Implied Market Price $14 per share Note: Our DCF analysis assumes a 15% discount rate, revenue growth accelerating to 65% in 2002 before declining to 8% in 2010, net margins improving to 20% by 2007 and a terminal value of roughly 12 times earnings. Source: Stephens Inc. and Company reports. Stephens Inc. 18
Slide 19: Figure 11 SPEECHWORKS INTERNATIONAL  Discounted Cash Flow Analysis (dollars in millions except per share amounts) 2000A 2001E Revenue $30.0 $49.1 Year-to-Year Change 63% Net Margin NM NM Earnings ($29.6) ($39.1) Depreciation & Amortization 1.9 10.0 Non-Cash Compensation 4.5 7.4 Other 4.1 (2.4) Cash from Operations ($23.6) ($31.5) Net Investments (17.6) (11.4) Free Cash Flow ($41.2) ($42.9) Year-to-Year Change Free Cash Flow Per Share (1.31) (1.37) Terminal Value 2001-2010 Cash Flows Per Share $4 Terminal Value Per Share $10 Total Discounted Value Per Share $14 Excess Cash Per Share $0 Implied Market Price $14 per share 2002E 2003E 2004E 2005E 2010E $74.6 $112.9 $169.3 $245.5 $588.0 52% 51% 50% 45% 8% NM 3% 8% 12% 17% ($22.0) $3.9 $13.5 $29.5 $100.0 10.0 10.0 10.0 10.0 10.0 7.4 7.4 7.4 7.4 7.4 (2.7) (3.6) (3.6) (3.6) (3.6) ($14.8) $17.7 $27.3 $43.3 $113.8 (6.0) (6.0) (7.5) (9.0) (10.0) ($20.8) $11.7 $19.8 $34.3 $103.8 69% 73% 7% (0.66) 0.37 0.63 1.09 3.30 $40.52 Note: Our DCF analysis assumes a 15% discount rate, revenue growth slowly declining to 5% in 2010, net margins improving to 17% by 2007 and a terminal value of roughly 12 times earnings. Source: Stephens Inc. and Company reports Catalysts For better or worse, the futures of Nuance and SpeechWorks are dependent on the same sector trends. While we recognize the distinct capabilities of each Company, we tend to believe that their stocks will be driven by similar catalysts and will face comparable risks. New Customers: To a certain extent, both Nuance and SpeechWorks are “show me” stocks in the sense that the shares may not appreciate significantly until the Companies prove that a viable market exists by adding new high-profile customers. Product Developments: Both Companies continue to bring new products to the market, which should eventually translate into revenue. Acquisition Announcements: Somewhat related to the preceding point, we expect that Nuance and SpeechWorks may make small acquisitions to add to their product and service portfolios. New Alliances and Partnerships: Although this is quickly changing, there is a lack of qualified integrators and developers in the speech recognition sector. We look for SpeechWorks and especially Nuance to benefit from the addition of high-quality resellers and integration partners. Resellers would generally include hardware vendors such as InterVoice-Brite, which is a key SpeechWorks partner and a developing Nuance relationship. Systems integrators would include specialists such as Gold Systems as well as the bigger name consultants such as Accenture. Stephens Inc. 19
Slide 20: Risks Competition: As we mentioned earlier in the report, we believe that IBM could pose a real threat, as it has both quality technology which could be and strong relationships with enterprise customers. Commoditization: There is at least a modest threat of commoditization of the core speech recognition technology. Both Companies licensed technology from third parties at their inception, and though their products have evolved, the core source code could conceivably be utilized by any potential competitor. Service Failures: The biggest barrier to growing the market is getting potential customers comfortable with the technology. Any integration or deployment problems could generate long-term ill will to the detriment of future revenues. It is interesting to note that most failures are more a function of faulty user interface design rather than a failure of the core recognition software. Growing Pains: Both Companies could potentially face a period of hyper-growth over the next couple of years. While we believe that both management teams are solid, it may be a challenge to grow the businesses at the pace of the market’s growth. CONCLUSION We recommend both NUAN and SPWX with OUTPERFORM ratings. Again, we recommend both Nuance and SpeechWorks with OUTPERFORM ratings based on our optimistic outlook for the speech recognition software market. We view both as leaders in an important but nascent market. While we do not expect spectacular results in 2001, we believe that customers are continuing to evaluate the technology and will likely begin to deploy speech recognition solutions more aggressively in 2002. In the short run, we favor SpeechWorks, because it has greater revenue visibility and emphasizes comprehensive solutions and customer service. Longer term, we tend to favor Nuance’s indirect sales strategy and forward-thinking technology mindset. Still, we believe that both Companies will benefit from positive market dynamics and that both will prove to be wise investments for those who can tolerate the risk. Our 12-month price targets for NUAN and SPWX are $20 and $19, respectively. Our 12-month price target for Nuance is $20.00, or 14% below its current price, and our target price for SpeechWorks is $19.00, or 31% above its current price. We will become even more bullish when we see one or more of the following: • • • An increase in overall corporate technology spending. Increased demand for speech recognition in various vertical industry solutions. Signs that Nuance and SpeechWorks will remain leaders in the industry, evidenced by continued Fortune 500 customer wins. Stephens Inc. 20
Slide 21: NUANCE COMPANY DESCRIPTION NUAN is a provider of software and services that enable the content and services of the Internet and telephone networks to be accessible from any telephone. Nuance, based in Menlo Park, California, is a provider of software and services that enable the content and services of the Internet and telephone networks to be accessible from any telephone. The Company’s software platform consists of software servers that perform speech recognition, natural language understanding, text-to-speech (TTS) synthesis and voice authentication. Nuance also provides professional services to facilitate the development, implementation and support of applications operating on its software platform. Nuance software products are based on research originally conducted by SRI International. Upon its inception, Nuance received a license from SRI International to a number of patents and other proprietary rights, including a right to software relating to voice interface technologies. Since then, the Company has invested significantly in developing and improving this core technology. The license was exclusive until December 1999; subsequent to that the Company allowed the exclusivity to lapse. Nuance’s software offerings include Nuance 7.0, the Company’s core voice recognition software; Speechify, a speech synthesis software; Nuance Vocalizer, a text-to-speech (TTS) engine; Application Development Tools; Nuance Verifier, a speaker verification software; and Nuance Voyager, a voice browser. The Company licenses its products to software and service providers as well as enterprises. In the first quarter 2001, about half of it’s revenue was derived from services, though this was unusually low due to a sharp decline in software license revenue (see Figure 12). In May 2001, Nuance introduced a new speech recognition technology “Say Anything.” In May 2001, Nuance introduced a new speech recognition technology “Say Anything.” Say Anything allows people to say whatever they want to speech systems to conduct transactions or obtain information. Until now, developers have built applications by predefining lists of what callers can say. Say Anything combines this capability with statistical models that recognize free-style speech and extract key concepts to determine the meaning of user input. Say Anything is not yet generating revenue. Figure 12 NUANCE COMMUNICATIONS  Revenue Composition, 1Q01— ended 3/31/01 (In millions) Total Revenue = $11.01 Licenses Services $5.3 49% $5.7 51% Source: Company reports and Stephens Inc. Stephens Inc. 21
Slide 22: Nuance’s core technology consists of speech recognition, natural language understanding, textto-speech (TTS) synthesis and voice authentication. Nuance’s core technology consists of speech recognition, natural language understanding, TTS synthesis and voice authentication. The Company uses the Hidden Markov model for voice recognition. Under this approach, digitized speech is divided into numerous short segments and statistical processes are used to analyze and interpret these segments. Natural language understanding is the ability of the software to extract relevant parts of the speech using rules established by the developer of the voice interface. The text-tospeech engine synthesizes text into speech, providing a natural sounding voice interface. Last but not least, voice authentication software provides security for applications using biometric speaker verification. Nuance sells its software and services across a variety of industries and market segments in the United States and internationally. Among the list of notable customers are American Airlines, Banco Bradesco, Charles Schwab, Fidelity Investments, OnStar, Sears, Siebel Systems and SprintPCS (see Figure 13). For instance, OnStar has integrated NUAN ‘s software into its virtual advisor platform that will deliver in-vehicle, hands-free access to a collection of Internet-based content. Cisco also announced a multi-year agreement with Nuance that will allow it to incorporate the Company’s speech recognition and voice authentication software into its Architecture for Voice, Video and Integrated Data (AVVID) products. More recently, Japan’s largest carrier, Japan Telecom, has licensed NUAN’s software to power its voice portal. Figure 13 NUANCE COMMUNICATIONS  Selected Customers Communications Bell Atlantic (now Verizon) British Telecommunications plc CTBC Telecom (Brazil) Deutsche Telekom (Germany) Sprint PCS Southwestern Bell Telenor (Norway) Telia (Australia) Z-Tel Technologies Technology/Manufacturing Dell Japan Ford Motor Company General Electric Co. Sony Japan Finance/Brokerage/Banking American Century American Express Financial Advisors Banco Itau (Brazil) Banco Mercantil (Venezuela) Charles Schwab & Co. Fidelity Investments Merrill Lynch Dot.coms Cheap Tickets Fingerhut Source: Company reports and Stephens Inc. Travel American Airlines Delta Airlines Other Avon Commonwealth of Virginia CTC Create (Japan) Dreyfus Corporation Entergy Corporation Home Shopping Network National Car Rental Systems, Inc. Odeon Cinemas (United Kingdom) OnStar Sears, Roebuck and Co. Siebel Systems United Parcel Service Voice Portals/Enhanced Service Providers BeVocal General Magic GoSolo Technologies GTG Technologies ShopTalk Tellme Networks Webversant Stephens Inc. 22
Slide 23: Software Products Nuance’s primary software products are Nuance 7.0, Nuance Vocalizer, Nuance Voyager, Nuance Web Server, SpeechObjects and the Nuance Developer’s Toolkit. Nuance 7.0 Nuance 7.0 is the Company’s flagship software that provides speech recognition and natural language understanding capabilities. Nuance 7.0 is the Company’s flagship software that provides speech recognition and natural language understanding capabilities. The software has a unique distributed architecture that supports concurrent load balancing of speech recognition, natural language understanding, voice authentication and text-to-speech synthesis. The architecture utilizes three primary components: the Recognition Server, Recognition Client and Resource Manager (see Figure 14). Figure 14 NUANCE COMMUNICATIONS  Nuance 7.0 Speech-Enabled Application Nuance Clients Resource Manager Nuance Server Nuance Server Nuance Server Nuance Server Source: Company documents and Stephens Inc. The Recognition Server performs speech recognition and verification. The Resource Manager balances the load across all the recognition servers. The Recognition Client interacts with the speech-enabled application. The unique architecture enables the separation of light client processing from volume CPU-intensive server processing. For a small system or a prototype, both the client and server can run on the same machine. The speech recognition and natural language understanding technology of the software is available for 25 languages and dialects. Stephens Inc. 23
Slide 24: Speech Recognition Software Customer Case Study (UPS) UPS, the world's largest package distribution company, needed a solution to enable its customers to schedule pickups and track packages using voice-only input. Touch-tone phones couldn't handle the 11- to 18-digit tracking numbers, and using customer service agents was too expensive. UPS utilized Nuance’s speech recognition software to develop an automatic speech recognition (ASR) application. Now, UPS customers can schedule pickups and track packages using voice. Source: Company reports and Stephens Inc. Nuance Verifier Nuance Verifier is a verification software that authenticates the identity of callers based on their unique voiceprint. Nuance Verifier is a verification software that authenticates the identity of callers based on their unique voiceprint. The software captures and stores the caller’s voiceprint during a short one-time enrollment process. Subsequently, callers who wish to enter the system just speak, and their voice is compared by the software against their previously enrolled voiceprint. If there is a match, the caller is accepted into the system. Speech Verification Customer Case Study (The Home Shopping Network) Operators at the Home Shopping Network (HSN) were handling roughly 48,000 calls per day from customers who had forgotten their HSN ID number. The company needed a solution that would automate the process to reduce costs. HSN utilized Nuance’s verification software to develop an ASR application. Today, customers calling HSN simply speak their phone numbers and are securely identified. The software provides a 95% automated rate in identifying and authenticating callers, so only 5% of callers are forwarded to an operator for assistance. Source: Company reports and Stephens Inc. Nuance Vocalizer Nuance Vocalizer is a text-to-speech software engine that converts text-based information into an audio format for access over the telephone. Nuance Vocalizer is a text-to-speech software engine that converts text-based information into an audio format for access over the telephone. The software retrieves the waveforms from a database of prerecorded human speech. The output sounds natural because the resulting speech is actually made up of concatenated units of human recordings. TTS should prove to be especially important in unified messaging, as it will allow e-mails to be “read” over the phone. Pricing is based on the number of TTS ports licensed. The list price per port is $600, but volume discounts are available. The software is currently available in developer’s release only, with general availability expected in first half of 2001. Stephens Inc. 24
Slide 25: Nuance Voyager Nuance Voyager is a voice browser that allows users to access traditional telephony applications, voice portals and voiceenabled Internet content via telephone. Nuance Voyager is a voice browser that allows users to access traditional telephony applications, voice portals and voice-enabled Internet content via telephone. The browser runs on the Nuance Voice Web Server and is built on the Company’s core speech recognition and voice authentication software. These integrated technologies allow callers to access secure content and conduct commerce over the telephone using sophisticated voiceprint capabilities. Nuance Voice Web Server Nuance Voice Web Server facilitates the creation and modification of voice sites for enterprises. The Server is comprised of the Nuance 7.0 Recognition Server and the Nuance VoiceXML Interpreter. VoiceXML Interpreter is a software that processes content developed in the Voice XML language. The combination of a recognition software and VoiceXML Interpreter allows enterprises to develop applications such as voice-activated dialing, telephone access to corporate intranets, and full-service voice portals that provide news, weather and stock quotes. SpeechObjects Nuance Voice Web Server facilitates the creation and modification of voice sites for enterprises. SpeechObjects are software components that developers utilize to create the voice user interface of an ASR application. SpeechObjects are software components that developers utilize to create the voice user interface of an ASR application. These components have published applicationprogramming interfaces that define the voice interface for specific tasks, such as request a spoken account number, postal code or country name. For instance, a speech object that understands a spoken date can be used for a banking transaction application. The Company provides a royalty-free license to the source code for a set of SpeechObjects that captures commonly used information such as dates, times and dollar amounts. Nuance Developer’s Toolkit The Developer’s Toolkit assists in the development, prototyping, deployment and optimization of voice user interfaces for ASR applications. Nuance Developer’s Toolkit assists in the development, prototyping, deployment and optimization of voice user interfaces for ASR applications. The toolkit includes 25 foundation SpeechObject software components, V-Optimizer, a tool for analyzing and tuning deployed applications, and V-Builder, a tool that allows developers to build applications using both VoiceXML and SpeechObject software components. Voice interfaces developed using the toolkit can be integrated with telephony applications written in C/C++ or Java. Professional Services In the most recent reported quarter (1Q01), roughly half of Nuance’s revenue came from professional services whereas in the prior quarter accounted for approximately 28% of total revenue. The higher-than-normal percentage of total revenue was a result of lowerthan-expected software sales. Nuance provides technical maintenance, development and support of its software products to its customers. In addition, the Company also offers prototype development, user interface design, grammar development, system testing, performance optimization and end-user acceptance studies. Developer education services are also offered. Stephens Inc. 25
Slide 26: Management Ronald Croen, President, Chief Executive Officer and Co-Founder. Mr. Croen has served as President since July 1994 and as CEO since October 1995. Prior to Nuance, he worked as a consultant to SRI International. From 1987 to 1989, he was with The Ultimate Corp. where he was Managing Director of European operations. Mr. Croen holds a J.D. from the University of Pennsylvania Law School and a B.A. from Tufts University. Dr. Michael Cohen, Vice President of Dialog Research & Development and CoFounder. Dr. Cohen is one of the three technical founders of the Company. Prior to cofounding Nuance, he spent ten years at SRI’s Speech Technology and Research Lab. Dr. Cohen received his Ph.D. from the University of California at Berkeley. Lee-Tyler Mun, Vice President and Chief Technology Officer. Mr. Mun joined Nuance as CTO in March 2001. Prior to that, he was CIO of Realnames Corporation. Previously, Mr. Mun has also held senior IT positions at Citigroup, Inc., Oracle Corporation, Tandem Computers and Atmel Corporation. He holds a B.S. in decision and information science from Santa Clara University. Paul Scott, Senior Vice President of Worldwide Sales. Mr. Scott has served in his present capacity since February 2000. Prior to that, he was Senior Vice President Sales at Lucent Technologies. Mr. Scott holds a B.S. in Arts and Masters of Arts degree from Nothwestern University. Graham Smith, Vice President and Chief Financial Officer. Mr. Smith has been CFO since 1998. Prior to that, he was Vice President of Finance, Worldwide Operations at Oracle. Mr. Smith holds a B.Sc. from Bristol University and is a member of the Institute of Chartered Accountants in England and Wales. SPEECHWORKS COMPANY DESCRIPTION SPWX is a provider of software and services that enable customers to offer over-thetelephone ASR systems. SpeechWorks International, based in Boston, Massachusetts, is a provider of software and services that enable customers to offer over-the-telephone automated speech recognition (ASR) solutions. The Company’s portfolio of products includes software for speech recognition, synthesis and verification. SpeechWorks also provides professional services to complement the sale, installation and operation of its products. SpeechWorks was co-founded in 1994 by Michael Phillips and William O’Farrell. Its software products incorporate patented technologies and are based on research originally conducted at the Massachusetts Institute of Technology (MIT) by Mr. Phillips and others. The Company pays royalties to MIT equal to a percentage of its product license revenue. In 2000, the percentage was 1.3%. SpeechWorks’ software offerings include SpeechWorks 6.5, its flagship platform for voice recognition solutions development; SpeechSite, a packaged application solution; Speechify, a speech synthesis software; ETI-Eloquence, a TTS speech engine; and SpeechSecure, a speaker verification software. The Company licenses its products to software and service providers as well as enterprises. Currently about 55% of it’s revenue is derived from software licensing and the remainder from services (see Figure 15). Stephens Inc. 26
Slide 27: SpeechWorks’ core technology consists of speech recognition and text-to-speech (TTS) synthesis. SpeechWorks’ core technology consists of speech recognition and text-to-speech (TTS) synthesis. The speech recognition system is based on work on segmental systems performed at MIT. The segmental approach takes into account the entire phonetic segment, thereby reducing the overall amount of computation needed for a given recognition task. Barge-in technology is a key feature of the speech recognition system that allows callers to interrupt the outgoing prompts by speaking over them. In January 2001, the Company acquired Eloquent Technology, a developer of TTS synthesis software. The acquisition helped add 12 new languages to its TTS product offerings. SpeechWorks’ TTS products now support 13 languages. In June 2000, SpeechWorks launched Open Speech Web, an initiative that attempts to connect a variety of speech services, including portals, enterprise SpeechSites and directory services. The Open Speech Web, based on VoiceXML, allows callers to freely navigate among speech-enabled services. To support the initiative, the Company offers a VoiceXML speech browser and SpeechLinks software. The software is available as open source code. SpeechWorks offers its products to a broad range of market segments. The Company offers its products to a broad range of market segments (see Figure 16). Continental Airlines, E*TRADE, FedEx and McKesson HBOC are some of the major customers. In a more recent development, Microsoft announced an agreement with SpeechWorks to license its Speechify TTS engine. According to the agreement, the engine will also support the latest version of Microsoft’s speech application programming interface (SAPI 5.0). The TTS engine will likely initially be deployed in MSN for unified messaging but could have broader uses. We are cautiously optimistic that Microsoft could eventually become a meaningful customer. Figure 15 SPEECHWORKS INTERNATIONAL  Revenue Composition, 1Q01 ended 3/31/01 (In millions) $0.9 * 9% Total Revenue = $11.1 Product Licenses Professional Services Other Revenues $4.0 37% $6.09 55% * Includes the effect of non-cash stock-based compensation Source: Company reports and Stephens Inc. Recently, SpeechWorks has also signed agreements with Union Pacific Railroad and ZTel Technologies. Union Pacific will speech-enable the operational process of releasing its empty railcars for its 30,000 freight customers, such as General Motors, while, Z-Tel has licensed the Speechify TTS engine. Stephens Inc. 27
Slide 28: Figure 16 SPEECHWORKS INTERNATIONAL  Selected Customers Communications BellSouth IntelliVentures CellularOne E-Plus WorldCom NEXTLINK Interactive (now XO Comm.) SingTel Mobile Technology/Manufacturing Apple Computer Aspect Communications CIBC CTL, Inc. Dialogic Corporation, an Intel company InterVoice-Brite Maxxar Corporation Nortel Networks Finance/Brokerage/Banking Bidwell and Company CIBC Citigroup CSFB Direct E*TRADE First Union National Bank Hyundai Securities Singapore Stock Exchange IT Solutions StockTrade TD Waterhouse Source: Company reports & Stephens Inc. Dot.coms Anyday.com foodline.com MapQuest.com Synapse.com Xypoint Corporation Travel AirTran Airways Amtrak Continental Airlines United Airlines Other McKessonHBOC Office Depot Stop & Shop, an Ahold/USA Company The Guardian Life Insurance Co. of America Speech Portals/Enhanced Service Providers !hey Software Audiopoint, Inc. everypath.com HeyAnita.com NetByTel.com PriceInteractive (now iBasis) Quack.com (acquired by AOL) SPWX’s Relationships with AT&T, AOL and Net2Phone SPWX’s contract with AT&T allows the Company to license, develop and sell products based on AT&T’s technology. In June 2000, SpeechWorks signed a five-year contract to license, develop and sell products based on AT&T’s technology. The technology primarily consists of AT&T’s speech and text-to-speech software. The license is royalty free and nonexclusive, but the Company has issued AT&T a little more than million shares of its common stock outstanding in return for these licenses. AT&T has also agreed to assist SPWX in marketing its products to AT&T’s business units and customers and may use these products for internal research and development. If the agreement is terminated, SPWX will retain the technology license that it received from AT&T. Stephens Inc. 28
Slide 29: SPWX’s contract with AOL covers areas such as software licensing, marketing and development of voice portals for AOL’s online services. Also in June 2000, SpeechWorks signed a strategic agreement with AOL. Under the agreement, SPWX has licensed its software to AOL and supports the development of voice portals to AOL’s online services. In addition, AOL serves as a distribution channel by licensing SpeechWorks’ software to third parties with content provided by AOL. We believe that this agreement will help SPWX to gain some brand recognition, as AOL has also agreed to place SPWX’s logo on select AOL Web pages. In connection with the agreement, AOL purchased over 400,000 shares of SPWX common stock in a private placement at a purchase price of $12.46. The Company also issued a warrant to AOL to purchase more than 765,000 shares of its common stock at an exercise price per share of $12.46. During the same time period, SPWX entered into a relationship with Net2Phone under which the Company has granted a software license to Net2Phone. SPWX also provides professional services to Net2Phone and pursue joint promotional and marketing efforts. Under the agreement, Net2Phone has acquired 321,000 shares of common stock in a private placement at a purchase price per share equal to $12.46. We believe these three relationships are important to SpeechWorks as they represent large potential customers and allow the Company to offer new products and differentiate itself from rivals. Software Products SPWX offers software products to enterprises and communications carriers that enable them to provide automated, speech-activated services (see Figure 17). Figure 17 SPEECHWORKS INTERNATIONAL  Examples of Speech-Activated Services Enabled By SpeechWorks International Customer Services Network Services Provided by a Provided by an Enterprise Communications Carrier Price quotes Weather conditions Order/account status/update Traffic updates Product information Horoscopes Directions News and sports reports Automated attendant/operator Speech-activated dialing Internal call routing Network call routing Voice/unified messaging Voice portals Flight booking Call completion Restaurant reservations Cellular bill payment Product purchase or sale Hosted services Function Information Retrieval Communications Management Transaction Processing Source: Company reports. SPWX’s software offerings consists of five separate speech recognition, synthesis and verification products for over-the-telephone applications. Stephens Inc. 29
Slide 30: SpeechWorks 6.5 SpeechWorks 6.5 is the current release of the Company’s software platform for developing and deploying customized speech applications. SpeechWorks 6.5 is the current release of the Company’s software platform for developing and deploying customized speech applications in a variety of languages. The platform consists of a core recognition engine, building blocks, development and tuning tools. From an architectural standpoint, the software fits between the telephony platform and the speech application (see Figure 18). Figure 18 SPEECHWORKS INTERNATIONAL  SpeechWorks Platform Source: Company documents The SMARTRecognizer engine is the foundation of the SpeechWorks 6.5 platform. It provides the technology for speech understanding capabilities over the telephone and can recognize more than 65,000 different words or phrases at each point in a call flow. Development and Tuning tools allow the developers to fine-tune and monitor the applications on an ongoing basis. DialogModules are patented, prepackaged software building blocks that enable developers to build speech applications. Each module performs a specific task within an application, such as capturing a Yes/no response or a telephone number from a caller to more complex tasks such as selecting an item from a large vocabulary list. SpeechWorks 6.5 is the Company’s most comprehensive product offering and is typically utilized in large custom speech application development projects. The platform is designed to be flexible, which is why it is not targeted towards a specific market segment. The Pricing of SpeechWorks 6.5 depends on number of employees and number of ports sufficient to handle the call volume. (Ports are telephone channels enabled to simultaneously play the output). Price per port varies from $1500 per port to $700, depending on the volume. Stephens Inc. 30
Slide 31: SpeechWorks platform Customer Case Study (United Airlines) United Airlines needed a solution to reduce the 1.5 million employee calls made by its own employees to its reservations representatives each year. By utilizing the SpeechWorks platform, United developed a prototype, integrated it with its existing middleware, performed several rounds of usability testing, refined the user interface and deployed the final version. Now its employees book their own flights instead of waiting to be connected to reservations representatives. Source: Company reports and Stephens Inc. SpeechSite SpeechSite is a packaged application solution that delivers information services to callers through voice interface. Built on the SpeechWorks 6.5 platform, SpeechSite is a packaged application solution that delivers information services to callers through voice interface. The idea behind SpeechSite is that is extending the Web model to the telephone. The Company offers SpeechSite as a complete, turnkey solution utilizing content supplied by the customer. The solution comes with the required hardware, software and professional services. The hardware platform currently consists of a Dell PC, running Windows NT, utilizing Intel’s Dialogic cards. The software consists of an engine that is responsible for executing the speech interface and connecting with the telephony system, and an administration component responsible for configurations and monitoring interfaces. The pricing of SpeechSite depends on the number of employees in an enterprise and the number of ports sufficient to handle the call volume. Entry level pricing starts at $40,000. SpeechSite Customer Case Study (McKesson HBOC) More than two-thirds of calls made to McKesson’s customer service were about routine questions and order placement. McKesson, a large pharmaceutical supply management and healthcare information technology company, needed a cost-effective solution to improve its information and transaction services. The company utilized SpeechWorks’ SpeechSite software to develop a custom information delivery application. The software application handles routine calls and allows customer service agents to focus on more complex issues. Source: Company documents and Stephens Inc. Speechify Speechify is a speech synthesis software that converts text input from any source in real time into a spoken audio format. Speechify is a speech synthesis software that converts text input from any source in real time into a spoken audio format, using sophisticated concatenation algorithms and actual human voice recordings (see Figure 19). The software was developed utilizing speech technology licensed from AT&T. Stephens Inc. 31
Slide 32: Figure 19 SPEECHWORKS INTERNATIONAL  SpeechWorks 6.5 Platform Source: Company documents The software comprises of a TTS engine and a voice database. The engine assimilates with the speech application and converts text inputs into a spoken voice over the telephony platform. Speechify has been integrated into popular consumer phone services such as AOL by Phone and Yahoo! by Phone. Since its launch in December 2000, Speechify has been integrated into popular consumer phone services such as AOL by Phone and Yahoo! by Phone, both of which allow subscribers to listen to incoming e-mail over any telephone. The software is sold to a broad range of customers that wish to extend their Web sites and databases to telephone users. Customers include Microsoft, Z-Tel, Webversa, NetByTel, and Net2Phone. Pricing is based on the number of TTS ports to be licensed. The list price per port is $650, but volume discounts are available. ETI-Eloquence ETI-Eloquence is a TTS speech engine that uses parametric synthesis technology to turn text-based content into spoken audio. ETI-Eloquence is a TTS speech engine that uses parametric synthesis technology to turn text-based content into spoken audio. The Company obtained the software through its acquisition of Eloquent Technology in January 2001. ETI-Eloquence has a small footprint that makes it practical for embedded devices such as in-car navigation systems, mobile phones and PDAs. The software is currently available in 13 languages. Price per port varies from $600 to $700 per port. SpeechSecure SpeechSecure is a speaker verification software. SpeechSecure is a speaker verification software that uses biometric technology to authenticate callers by their unique voiceprint. The software is based on technology licensed from both T-NETIX and Veritel. SpeechWorks currently offers the software as a DialogueModule (software building blocks) that customers can include in their voice applications. Stephens Inc. 32
Slide 33: Professional Services Approximately 37% of SpeechWorks’ revenue is derived from professional services. In addition to standard maintenance and support, it offers business consulting, project management, and application development. The Company also offers training in VoiceXML development through its Rapid Prototyping Center and SpeechWorks Institute. The prototyping center also allows potential customers to cost-effectively evaluate the capabilities of speech-activated applications. We should also mention that SpeechWorks’ highly regarded professional services business posts very respectable gross margins in the 30%-plus range. Management Stuart R. Patterson, Chief Executive Officer. Mr. Patterson joined the Company as President in September 1997 and became the CEO in May 1998. Prior to SpeechWorks, he served on the Board of BBG New Media, Inc. and held various management positions at Hewlett-Packard and Vicorp. Mr. Patterson went to college at Harvard University and attended graduate school at Yale. Richard J. Westelman, Chief Financial Officer. Mr. Westelman has served as the Company’s CFO since August 1998. Prior to that, he served as CFO at Dove Associates from June 1996 to August 1998. Mr. Westelman also spent four years at Pepsi where he was involved in acquisitions and business planning. He went to college at Harvard University and attended graduate school at Yale. Michael S. Phillips, Chief Technology Officer and Co-Founder. Mr. Phillips cofounded the Company in 1994. Before that, he was a Research Scientist in the Spoken Language Systems Group at the Massachusetts Institute of Technology. Mr. Phillips holds a B.S. in electrical engineering from Carnegie-Mellon University. Mark A. Holthouse, Senior Vice President Operations. Mr. Holthouse has held his position since joining the Company in March 1998. Previously, he co-founded Vicorp and served as its Managing Director from April 1987 to March 1996. Mr. Holthouse holds a B.S.E.E. from MIT and an MBA from Boston University. Joseph Murphy, Vice President Sales. Mr. Murphy has been as Vice President of Sales since August 1999. Prior to that, he held the same position at Rubric Inc., a Web-based marketing vendor. From August 1996 to June 1998, he was Director of Sales at Genesys Telecommunications. Mr. Murphy holds a B.A. in marketing from Boston College. Stephens Inc. 33
Slide 34: Public companies mentioned in this report: 724 Solutions Inc. (SVNX–$9.08) Aether Systems, Inc. (AETH–$12.03, NEUTRAL) Air Tran Holdings, Inc. (AAI–$10.59) AOL Time Warner Inc. (AOL–$51.00), a parent of MapQuest.com, Inc.; acquired Quack.com American Express Financial Advisors (AXP–$42.12) Ameritrade Holding Corporation (AMTD–$8.48) AMR Corporation (AMR–$38.29), parent of American Airlines ANC Rental Corporation (ANCX-$5.27), parent of National Rental Car System Apple Computer, Inc. (AAPL–$21.47) Aspect Communications Corporation (ASPT–$6.31) @t Road Inc. (ARDI–$2.05) AT & T Corp. (T–$21.17) AT&T Wireless Group (AWE–$17.30) AvantGo Inc. (AVGO–$3.10) Avaya Inc. (AV–$16.89) Avon Products, Inc. (AVP–$44.07) Banco Bradesco S.A. (BBQCY–$5.18) BellSouth Corporation (BLS–$40.80) British Airways plc (BAB–$54.94) British Telecommunications plc (BTY–$63.74) Canadian Imperial Bank of Commerce (CIBC) (BCM–$32.70) Certicom Corp. (CERT–$9.52) Cheap Tickets (CTIX–$12.35) Cisco Systems, Inc. (CSCO–$20.46) Citigroup Inc. (C–$51.60) Comverse Technology, Inc. (CMVT–$58.60) Continental Airlines, Inc. (CAL–$49.50) CSFBdirect Inc. (DIR–$5.02), formerly DLJ Direct Dell Computer Corp. (DELL–$24.61) Delta Airlines, Inc. (DAL–$47.02) Deutsche TeleKom AG, (DT–$21.12) E*TRADE Group, Inc. (ET–$7.86) Entergy Corporation (ETR–$43.50) ePlus Inc. (PLUS–$9.38) Extended Systems Incorporated (XTND–$8.40, NEUTRAL) Federated Department Stores Inc. (FD–$44.88), parent of Fingerhut Co. Inc. FedEx Corporation (FDX–$39.64) Fonix Corporation (FONX–$0.41) Ford Motor Company (F–$24.99) General Electric Company (GE–$49.67) General Magic, Inc. (GMGC–$1.18) Stephens Inc. 34
Slide 35: General Motors Corporation (GM–$57.33), owns OnStar GoAmerica, Inc. (GOAM–$2.85) iBasis Speech Solutions (IBAS–$3.90), formerly PriceInteractive International Business Machines Corporation (IBM–$115.27) InfoSpace, Inc. (INSP–$4.25) Intel Corp. (INTC–$28.74) InterVoice-Brite, Inc. (INTV–$10.58) Lernout & Hauspie Speech Products N.V. (LHSPQ–$6.25) Lucent Technologies Inc. (LU–$8.32) McKesson HBOC, Inc. (MCK–$34.03) (MEL–$45.70, BUY) a parent of Dreyfus Corporation Merrill Lynch & Co., Inc. (MER–$65.60) Microsoft Corporation (MSFT–$70.34) $14.70) Net2Phone, Inc. (NTOP–$9.35) Nortel Networks Corporation (NT–$13.33) Nuance Communications, Inc. (NUAN–$14.96, OUTPERFORM) Office Depot, Inc. (ODP–$9.70) OmniSky Corporation (OMNY–$2.30) Openwave Systems Inc. (OPWV–$41.73, NEUTRAL) Philips Electronics N.V. (PHG–$27.70) Portal Software, Inc. (PRSF–$5.31) Pumatech, Inc. (PUMA–$3.95, OUTPERFORM) Royal Ahold N.V. (AHO–$30.42), parent of The Stop & Shop Companies SBC Communications Inc. (SBC–$43.18), parent of Southwestern Bell, (see Cellular One) Sears, Roebuck & Company (S–$40.68) Siebel Systems, Inc. (SEBL–$45.36) SignalSoft Corporation (SGSF–$7.99) Singapore Telecommunications (SGTJY–$10.35), (also known as SingTel) Sony Corporation (SNE–$79.19) SpeechWorks International, Inc. (SPWX–$13.94, OUTPERFORM) Sprint PCS Group (PCS–$22.45) Sun Microsystems, Inc. (SUNW–$16.63) TD Waterhouse Group, Inc. (TWE–$11.92) T-NETIX, Inc. (TNTX-$2.68) TeleCommunications Systems, Inc. (TSYS–$3.99, OUTPERFORM) The Charles Schwab Corporation (SCH–$19.76) The Nomura Securities Co., Ltd. (NRSCY–$215.00) UAL Corporation (UAL–$37.23), parent co. of United Airlines Union Pacific Corporation (UNP–$57.70) United Parcel Service (UPS–$58.80) USA Networks, Inc. (USAI–$25.19), parent of The Home Shopping Network ns Inc. (VZ–$54.85), formerly Bell Atlantic and GTE Western Wireless Corporation (WWCA–$42.96), a sub. of Cellular One Group Stephens Inc. 35
Slide 36: WorldCom, Inc. (WCOM–$18.25) XO Communications Inc. (XOXO–$2.91), formerly NEXTLINK Communications Yahoo! Inc. (YHOO–$18.79) Z-Tel Technologies, Inc. (ZTEL–$2.07, OUTPERFORM) Private and Foreign Companies mentioned in this report: !hey Software Accenture (formerly Andersen Consulting) American Century Anyday.com Audiopoint Inc. Banco Itau (Brazil) Banco Mercantil (Venezula) BeVocal, Inc. Bidwell and Company Cellular One Group, partnership composed of subsides of Western Corp. and SBC Wireless CTBC Telecom (Brazil) CTC Create (Japan) Eloquent Technology (acquired by SpeechWorks) everypath.com First Union National Bank FMR Corp. (also known as Fidelity Investments) foodline.com Gold Systems Inc. GoSolo Technologies GTG Technologies Inc. HeyAnita Inc. Hyundai Securities Japan Telecom Co. Ltd. (Tokyo Exchange) Locus Maxxar Corporation NetByTel Odeon Cinemas (United Kingdom) OnStar ShopTalk SingTel Mobile SRI International (non-profit) Stock Trade Synapse Communications Telenor (Norway) Tellme Networks The Guardian Life Insurance Company of America Veritel Technologies Inc. 36 Stephens Inc.
Slide 37: Webservant Webversa, Inc. Xypoint Corporation Stephens Inc. maintains a market in the common stock of Aether Systems, Extended Systems, Nuance Communications, Openwave Systems, Pumatech, SpeechWorks International, TeleCommunications Systems and Z-Tel Technologies and may act as principal in these transactions. Stephens Inc. has managed or comanaged an underwriting for Z-Tel Technologies within the past three years. LTM = last 12 months; NTM = next 12 months; STM = second 12 months BUY—one-year price appreciation expected to be greater than 20%; MARKET OUTPERFORMER—oneyear price appreciation expected to be between 10% and 20%; NEUTRAL—one-year price appreciation expected to be less than 10%; SELL—whenever warranted. Stephens Inc. 37
Slide 38: Figure 20 NUANCE COMMUNICATIONS  Earnings Model, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) 06/04/01 REVENUE Licenses Year-to-Year Change Services Year-to-Year Change Total Revenue Year-to-Year Change Total Cost of Revenue Year-to-Year Change Gross Profit Year-to-Year Change Gross Margin Year-to-Year Point Change OPERATING EXPENSES Year-to-Year Change Revenue Year-to-Year Change Expenses Year-to-Year Change Operating Income Year-to-Year Change Operating Margin Year-to-Year Point Change Interest and Other Income, Net 1QA $6.0 46% $1.9 133% $7.9 60% $1.6 36% $6.3 68% 79.8% 3.6 $13.87 155% $7.94 60% $15.47 134% ($7.53) (354%) NM NM 0.32 (7.21) 0.0% 0.00 ($7.21) ($0.31) ($0.26) 23.5 2QA $8.7 211% $3.3 89% $12.0 164% $2.1 53% $9.9 213% 82.2% 12.8 $16.55 133% $12.00 164% $18.68 120% ($6.68) (70%) NM NM 1.15 (5.52) (2.6%) 0.15 ($5.67) ($0.20) ($0.16) 28.8 3QA 4QA 2000A $37.6 176% $14.3 140% $51.8 165% $10.8 97% $41.1 191% 79.3% 7.2 $70.89 113% $51.82 165% $86.21 102% ($29.83) (56%) NM NM 6.70 (23.12) (1.5%) 0.35 ($23.47) ($0.83) ($0.59) 28.4 1QA 2QE 3QE 4QE 2001E 1QE 2QE $9.9 95% $5.8 22% $15.8 59% $4.1 (5%) $11.7 110% 73.8% 17.7 $20.96 (1%) $15.79 59% $25.10 (1%) ($9.31) 40% NM NM 2.50 (6.81) (2.0%) 0.14 ($6.95) ($0.21) ($0.18) 33.2 3QE 4QE 2002E $46.0 109% $24.0 17% $70.0 65% $17.0 (2%) $53.0 111% 75.7% 16.4 $83.85 (1%) $70.04 65% $100.84 (1%) ($30.83) 48% NM NM 9.79 (21.04) (32.5%) 0.42 ($21.46) ($0.64) ($0.53) 33.3 Pretax Income Tax Rate Provision For Taxes Net Income Earnings Per Share Pro Forma Cash EPS* Shares Outstanding $10.5 $12.4 291% 209% $4.0 $5.0 137% 198% $14.5 $17.4 231% 206% $3.1 $3.9 146% 141% $11.4 $13.5 266% 232% 78.6% 77.5% 7.5 6.1 $17.42 $23.06 97% 94% $14.46 $17.41 231% 206% $20.51 $26.98 103% 100% ($6.05) ($9.57) (6%) (22%) NM NM NM NM 1.53 3.69 (4.52) (5.87) (1.9%) (2.0%) 0.09 0.12 ($4.61) ($5.99) ($0.15) ($0.19) ($0.12) ($0.08) 29.8 31.5 $5.7 $5.1 $5.4 $5.9 $22.0 $7.7 (6%) (41%) (49%) (52%) (41%) 35% $5.3 $4.8 $5.1 $5.3 $20.5 $5.6 179% 45% 26% 5% 44% 4% $11.0 $9.9 $10.4 $11.2 $42.5 $13.2 39% (17%) (28%) (36%) (18%) 20% $4.9 $4.4 $4.1 $4.0 $17.3 $3.9 205% 104% 31% 2% 61% (19%) $6.1 $5.6 $6.3 $7.2 $25.2 $9.3 (3%) (44%) (44%) (47%) (39%) 52% 55.6% 56.0% 60.9% 64.2% 59.3% 70.2% -24.2 -26.2 -17.7 -13.3 -20.0 14.6 $22.60 $21.07 $21.07 $19.96 $84.70 $20.96 63% 27% 21% (13%) 19% (7%) $11.01 $9.91 $10.40 $11.19 $42.50 $13.22 39% (17%) (28%) (36%) (18%) 20% $27.49 $25.42 $25.14 $23.97 $102.02 $24.90 78% 36% 23% (11%) 18% (9%) ($16.49) ($15.52) ($14.74) ($12.78) ($59.52) ($11.68) (119%) (132%) (144%) (34%) (100%) 29% NM NM NM NM NM NM NM NM NM NM NM NM 3.00 2.90 2.80 2.70 11.39 2.60 (13.49) (12.62) (11.94) (10.08) (48.13) (9.08) (2.0%) (2.0%) (2.0%) (2.0%) 1.1% (2.0%) 0.15 0.25 0.24 0.20 0.84 0.18 ($13.64) ($12.87) ($12.18) ($10.28) ($48.97) ($9.26) ($0.43) ($0.40) ($0.37) ($0.31) ($1.51) ($0.28) ($0.36) ($0.33) ($0.31) ($0.28) ($1.29) ($0.25) 32.0 32.4 32.6 32.8 32.4 33.0 $12.9 $15.5 142% 164% $6.1 $6.4 22% 22% $19.1 $22.0 83% 96% $4.4 $4.6 7% 15% $14.7 $17.4 132% 142% 77.1% 79.1% 16.2 14.9 $20.96 $20.96 (1%) 5% $19.07 $21.96 83% 96% $25.32 $25.55 1% 7% ($6.25) ($3.59) 58% 72% NM NM NM NM 2.40 2.30 (3.86) (1.29) (2.0%) (2.0%) 0.08 0.03 ($3.93) ($1.32) ($0.12) ($0.04) ($0.09) ($0.01) 33.4 33.6 *Excludes amortization of goodwill and other non-cash charges A-Actual. E-Stephens Inc. estimate. Source: Company documents and Stephens Inc. Stephens Inc 38
Slide 39: Figure 21 NUANCE COMMUNICATIONS — Financial Data FY2000A-FY2002E (dollars in millions, except per share amounts) STATEMENT OF CASHFLOWS Cash Flow from Operations Earnings (loss) from Continuing Operations Depreciation & Amortization Deferred Taxes Other Cash from Operations Net Investments Free Cash Flow Cash Flow from Financing Dividend Change in Equity Change in Debt Cash from Financing Change in Cash Beginning Cash Ending Cash 2000A ($23.47) 2.66 0.00 (0.28) (21.09) (9.13) (30.21) 2001E ($48.97) 6.00 0.00 (2.44) (45.41) (32.00) (77.41) 2002E ($21.46) 6.00 0.00 (2.83) (18.29) (6.00) (24.29) 0.00 233.58 (2.38) $231.20 200.97 18.07 $219.05 0.00 0.00 0.00 $0.00 (77.41) 219.05 $141.63 0.00 0.00 0.00 $0.00 (24.29) 141.63 $117.34 BALANCE SHEET Total Assets Debt Total Liabilities Total Shareholders' Equity Total Liabilities and Equity A-Actual. E-Stephens Inc. estimate Source: Company Document and Stephens Inc. 2000A $279.34 0.03 27.35 251.99 $279.34 2001E $233.21 0.03 30.19 203.02 $233.21 2002E $215.64 0.03 34.08 181.56 $215.64 Stephens Inc. 39
Slide 40: Figure 22 SPEECHWORKS INTERNATIONAL  Earnings Model, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) 06/04/01 REVENUE Product Licenses Year-to-Year Change Professional Services Year-to-Year Change Other Revenues 1QA $2.6 665% $2.2 96% 2QA $2.8 164% $2.4 44% 3QA 4QA 2000A $16.4 344% $11.3 89% 1QA $6.1 134% $4.4 102% 2QE $6.1 119% $4.8 103% 3QE $6.4 32% $5.3 71% 4QE 2001E $7.0 15% $5.8 60% $25.6 57% $20.3 80% 1QE $8.1 33% $6.4 46% 2QE $9.3 53% $7.0 46% 3QE $10.7 67% $7.7 46% 4QE $12.3 75% $8.5 46% 2002E $40.4 58% $29.7 46% 5.7 29.8% (1.2) $74.6 52% $25.8 38% $48.8 61% 65.4% 3.5 $74.90 0% $74.57 52% $100.99 8% ($26.10) 41% NM NM 4.14 (21.96) (32.5%) 0.06 ($22.02) ($0.67) ($0.28) 33.1 $4.9 $6.1 562% 294% $3.1 $3.6 138% 91% Year-to-Year Change Non-cash Stock Based Compensation Year-to-Year Change 0.3 0.9 -82.6% -19.9% 0.7 0.8 2.7 1.0 29.1% -12.0% -38.9% 195.7% (0.3) 1.0 1.2 17.4% 70.9% 1.3 4.4 1.3 1.4 1.5 1.5 59.8% 64.8% 39.8% 33.4% 27.3% 21.6% (0.3) $15.5 40% $5.6 35% $9.9 43% 63.7% 1.4 $18.73 2% $15.51 40% $24.35 8% ($8.84) 23% NM NM 1.16 (7.68) (0.3%) 0.02 ($7.70) ($0.24) ($0.12) 32.6 (0.3) $17.4 50% $6.1 37% $11.3 58% 64.8% 3.2 $18.73 0% $17.43 50% $24.86 7% ($7.44) 36% NM NM 1.06 (6.38) (0.3%) 0.02 ($6.39) ($0.19) ($0.08) 32.9 (0.3) $19.6 56% $6.7 40% $12.9 67% 65.8% 4.2 $18.73 0% $19.59 56% $25.42 8% ($5.83) 47% NM NM 0.96 (4.87) (0.3%) 0.01 ($4.88) ($0.15) ($0.04) 33.2 (0.3) $22.0 60% $7.3 40% $14.7 72% 66.8% 4.6 $18.73 0% $22.05 60% $26.04 9% ($3.99) 61% NM NM 0.96 (3.03) (0.3%) 0.01 ($3.04) ($0.09) $0.02 33.5 Total Revenue Year-to-Year Change Total Cost of Revenue Year-to-Year Change Gross Profit Year-to-Year Change Gross Margin Year-to-Year Point Change OPERATING EXPENSES Year-to-Year Change Revenue Year-to-Year Change Expenses Year-to-Year Change Operating Income Year-to-Year Change Operating Margin Year-to-Year Point Change Interest and Other Income, Net Pretax Income Tax Rate Provision For Taxes Net Income Earnings Per Share Pro Forma Cash EPS* Shares Outstanding A-Actual. E-Stephens Inc. estimate. Source: Company documents and Stephens Inc $5.1 $6.0 55% 59% $2.0 $2.7 (11%) 28% $3.1 $3.3 192% 97% 61.0% 55.0% 28.7 10.8 $9.21 $10.67 160% 139% $5.09 $6.03 55% 59% $11.19 $13.38 94% 103% ($6.11) ($7.35) (147%) (164%) NM NM NM NM 0.01 0.10 (6.10) (7.25) 0.0% 0.0% 0.00 0.00 ($6.70) ($13.31) ($0.33) ($0.59) ($0.29) ($0.29) 20.0 22.4 $8.6 237% $3.1 96% $5.5 465% 64.0% 25.8 $14.84 199% $8.62 237% $17.95 174% ($9.32) (134%) NM NM 1.33 (7.99) 0.0% 0.00 ($8.29) ($0.30) ($0.20) 27.7 (0.3) (0.3) (0.3) (0.3) (0.3) (1.2) NM NM $10.3 $30.0 $11.1 $11.6 $12.5 $13.8 $49.1 136% 114% 118% 93% 45% 34% 63% $3.2 $11.0 $4.2 $4.5 $4.8 $5.2 $18.7 35% 33% 111% 65% 55% 65% 70% $7.1 $19.1 $6.9 $7.2 $7.7 $8.6 $30.4 252% 232% 123% 116% 40% 21% 60% 69.2% 63.5% 62.4% 61.6% 61.7% 62.2% 62.0% 22.8 22.5 1.3 6.6 -2.3 -7.0 -1.5 $16.87 $51.59 $18.43 $18.73 $18.73 $18.73 $74.61 98% 140% 100% 76% 26% 11% 45% $10.28 $30.02 $11.10 $11.63 $12.52 $13.81 $49.06 136% 114% 118% 93% 45% 34% 63% $20.04 $67.12 $22.61 $23.20 $23.53 $23.94 $93.28 85% 84% 102% 73% 31% 20% 39% ($9.75) ($32.53) ($11.51) ($11.57) ($11.00) ($10.14) ($44.22) (50%) (107%) (88%) (57%) (18%) (4%) (36%) NM NM NM NM NM NM NM NM NM NM NM NM NM NM 1.81 3.24 1.46 1.36 1.26 1.16 5.24 (7.95) (29.29) (10.05) (10.21) (9.75) (8.98) (38.98) (3.9%) (1.1%) (0.3%) (0.3%) (0.3%) (0.3%) 1.1% 0.31 0.31 0.03 0.03 0.03 0.02 0.10 ($8.26) ($36.55) ($10.08) ($10.23) ($9.77) ($9.00) ($39.08) ($0.27) ($1.46) ($0.32) ($0.32) ($0.31) ($0.28) ($1.23) ($0.17) ($0.92) ($0.19) ($0.21) ($0.19) ($0.16) ($0.82) 30.2 25.0 31.4 31.7 32.0 32.3 31.9 *Excludes amortization of goodwill and other non-cash charges Stephens Inc 40
Slide 41: Figure 23 SPEECHWORKS INTERNATIONAL  Financial Data, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) STATEMENT OF CASHFLOWS Cash Flow from Operations Earnings (loss) from Continuing Operations Depreciation & Amortization Deferred Taxes Other Cash from Operations Net Investments Free Cash Flow Cash Flow from Financing Dividend Change in Equity Change in Debt Cash from Financing Change in Cash Beginning Cash Ending Cash 2000A ($29.60) 1.89 0.00 4.12 (23.58) (17.57) (41.15) 2001E ($39.08) 10.00 0.00 (2.41) (31.49) (11.40) (42.89) 2002E ($22.02) 10.00 0.00 (2.75) (14.77) (6.00) (20.77) 0.00 129.56 (0.72) $128.84 87.73 11.47 $99.20 0.00 0.00 0.00 $0.00 (42.89) 99.20 $56.31 0.00 0.00 0.00 $0.00 (20.77) 56.31 $35.54 BALANCE SHEET Total Assets Debt Total Liabilities Total Shareholders' Equity Total Liabilities and Equity A-Actual. E-Stephens Inc. estimate Source: Company Document and Stephens Inc. 2000A $144.37 0.29 12.94 131.44 $144.37 2001E $107.86 0.29 15.51 92.36 $107.86 2002E $89.77 $0.29 $19.43 $70.33 $89.77 Stephens Inc 41